China's Exchange-Rate Challenge
Whatever happens to the renminbi in 2023, the People's Bank of China would do well to maintain its policy of benign neglect, allowing the exchange rate to act as an automatic stabilizer, while treating capital controls as the last resort. In short, the government should focus on growth and let the market take care of the renminbi.
BEIJING – The renminbi’s value used to feature heavily in debates about global imbalances. While outsiders considered it to be undervalued and urged appreciation, the People’s Bank of China (PBOC) insisted on maintaining the currency’s de facto peg to the US dollar. In recent years, however, China’s concerns that its currency would grow too strong have been replaced by fears of a sharp depreciation.
Though China has sustained its current-account surplus, capital outflows have been putting the exchange rate under frequent downward pressure since 2015. The sources of the pressure can be divided into three broad categories, based on the drivers of the outflows: deteriorating domestic economic conditions, non-economic factors, and arbitrage.
In 2015, while equity prices crashed and led to months of market turbulence, and GDP growth was losing its momentum, the PBOC introduced a new rule for setting the renminbi central parity rate against the US dollar to make the renminbi exchange rate more flexible. Though the move itself was correct, it triggered a sudden rise in expectations of renminbi depreciation. With that, capital began flowing out of China – and continued to do so through the end of 2016. To shore up the renminbi, the PBOC burned through some $1 trillion in foreign-exchange reserves during this period.
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